EXPANDING THE

BOUNDARIES OF
BANKING
Chapter 14
Expected Learning Outcomes:

After studying the chapter; you should be able to…

1. Know the major changes in the activities of the banks for the last 5
decades
2. Understand the nature of “off-balance-sheet activities” and give
example of such
3. Explain the concept of “Shadow banking”
4. Describe why investment banks are considered involved in shadow
banking
5. Describe the typical division within the investment bank’s
organizations
6. Describe the classification of firms engaged in investment banking
according to size
7. Describe the areas of business of investment banks
8. Explain how investment banks make money or incurs losses
EXPANDING THE BOUNDARIES OF BANKING
INTRODUCTION

The activities of banks have changed dramatically during the

past five decades. Between 1960 and 2018, banks
1. increased the amount of funds they raise from time
deposits and negotiable certificate of deposits;
2. increased their borrowing from repurchase agreements;
3. reduced their reliance on commercial and industrial
loans and on consumer loans;
4. increased their reliance on real state loans; and
5. expanded into nontraditional lending activities and into
activities where their revenue is generated from fees
rather than from interest.
Off-Balance-Sheet
Activities
1. Loan commitments
A bank earns a fee for a loan commitment. In a loan
commitment, a bank agrees to provide a borrower with a
stated amount of funds during a specified period of time.
The fee is usually split into two positions:

a) upfront fee when the commitment is written and

b) non-usage fee on the unused portion of the loan.

Interest is charged for loans are actually made. It is

usually marked up over a benchmark lending rate.
2. Standby letters of credit

With a standby letter of credit, the bank commits to

lend funds to the borrower - the seller of the
commercial paper - to pay off its maturing
commercial paper.

This is also availed of in connection with

importation of goods by the businessmen.
3. Loan sales
A loan sale is a financial contract in which a bank agrees
to sell the expected future returns from an underlying
bank loans to a third party. Loan sales, also called
secondary loan participations involve sale of loan
contract without recourse, which means that the bank
does not provide any guarantee on the value of the loan
sold and no insurance.

With securitization, instead of the bank holding the loans

in their own portfolio, it converts bundles of loans into
securities that are sold directly to investors through
financial markets.
 4. Trading activities

Banks earns fees from trading in the multibillion-

dollar markets for futures, options, and interest-rate
swaps. Bank trading in these markets is primarily
related to hedging the banks' own loan and
securities portfolios or to hedging services provided
for bank customers.
▪ As the beginning of financial crisis of 2007-
2009, most people were unfamiliar with
such terms are mortgage-backed
securities (MBSs), collateralized obligation
(CDOs), and credit default swaps (CDDs).

▪ These nonbank financial institutions have

been labeled the "Shadow Banking" system
because while they match savers and
borrowers, they do so outside the
commercial banking system.
INVESTMENT BANKS

➢ Investment banks offer distinct financial services,

dealing with larger and more complicated
financial deals than retail banks.

➢ Investment banks assist in the initial sale of

securities in the primary market, securities
brokers and dealers assist in the trading of
securities in the secondary markets. Finally
venture capital firms provide funds to companies
not yet ready to sell securities to the public.
ROLE OF INVESTMENT BANKS
1. The first is corporate advising, meaning that
they help companies take part in mergers and
acquisitions, create financial products to sell,
and bring new companies to market.
2. The second is the brokerage division where
trading and market-making - in which the
investment bank provides mediation between
those who want to buy shares and those who
want to sell-take place.
Typical divisions within investment banks
include
1. Industry coverage groups are established to have separate
groups within the bank each having expertise in specific
industries or market sections such as technology or health
care. They develop client relationships with companies
within various industries to bring financing, equity issue or
merger and acquisition business to the bank.

2. Financial products groups provide investment banking

financial products such as IPOs, M&As, Corporation
restructuring and various types of financing. There may be
separate product groups that specialize in asset financing,
leasing, leveraged financing and public financing.
TYPES
OF
FIRMS
ENGAGED
IN
INVESTMENT
BANKING
A. BULGE BRACKET BANKS

- Are the major international investing banking firms with

easily recognizable names such as.

- Each of the bulge bracket bank operates

internationally and has the largest global as well
as domestic presence.
They provide their clients with the full range
of investment banking services including:

1. Trading all the types of financing asset

management service

2. Equity research and issuance

3. M & A services
B. MIDDLE-MARKET BANKS

- Middle-market banks occupy the middle

position between smaller regional
investment banking firms and massive bulge
bracket investment banks.
C. BOUTIQUE BANKS
1. REGIONAL BOUTIQUE BANKS

- The smallest of the investment banks, both in terms of firm size and
typical deal size.

- They commonly serve smaller firms and organization but may have
as clients major corporations head quartered in their areas.
2. ELITE BOUTIQUE BANKS

- There are often like regional boutique in that they usually do not
provide a complete range of investment banking services and may
limit their operations to handling M & A issues.

- They are most likely to offer restructuring and asset management

services.
AREAS Of BUSINESS
A. BROKERAGE
A. BROKERAGE

Proprietary Trading – Investment banks have their own funds and they can both inv est and
trade their own money, subject to certain conditions.
A. BROKERAGE

Acting as a broker – Banks can match inv estors who want to buy shares with companies
wanting to sell them, in order to create a market for those shares ( known as market -making )
B. CORPORATE ADVISING
1. Bringing companies to market – Investment banks can raise funds for new issues,
underwriting initial public offerings ( IPO s) in exchange for a cut of the funds they raised.

2. Bringing companies together – Bank facilitate mergers and acquisition ( M & A ) by

adv ising on the v alue of companies the best way to proceed and how to raise capital.
HOW
INVETSMENT
BANKS
MAKE
OR
LOSE
MONEY
MAKING MONEY
- Bank receiv e fees for prov iding advice, underwriting
serv ices, loans and guarantees, brokerage serv ices and
research and analysis.

-They also receiv e div idends from inv estments they hold,
interest from loans and change a margin on financial
transaction they facilitate.
LOSING MONEY
- The adv ising div ision may end up holding unwanted
shares if they take-up of an IPO is lower than expected.
The trading div ision of bank may make the wrong
decision and end up losing the bank money.

- In a year of little corporate activ ity may have to rely on

trading profits to bolster their returns. Banks may create
financial products which they fail to sell on the other
inv estors, leav ing them holding loss-making security or
loans.